Krugman on Fire for Faulty Finance

Keynesians are nothing if not versatile. Until ObamaCare was signed into law, Paul Krugman was a "healthcare" economist (which really is a person with a Ph.D. in economics who believes that government can work magic through coercion in doling out medical care).

However, at this time, Krugman now is foremost a "financial" economist, which means a person with a Ph.D. in economics who believes that government can run the nation's financial system with brilliance and efficiency. Yes, yes, I know that there is this problem with the government's accounting methods (although Krugman believes that government under Democrats, no matter how fraudulent its accounting methods, still is magic), but Krugman being a True Believer thinks that government regulators are omniscient (if they are "smart" and they "believe in government") and can get past the problems that would bedevil most mortals.

In his Friday, April 16, column, Krugman repeats his usual tricks of rewriting history and then claiming that all that is needed to "save" the financial system is to bring back the financial cartels that dominated U.S. finance from the New Deal until the early 1980s. Of course, that means his methods are utterly predictable: claim that Republicans want financial failure and then blame Ronald Reagan for everything. In other words, truth really does not matter.

Before going further, let me emphasize that I have no faith in whatever Republicans are promoting in Congress. When they were in power, they used Wall Street like their own private piggy bank, and it blew up in their faces. Nonetheless, while I don't trust them in power, I do find that at least some of the rhetoric they are using now actually has some truth in it.

In likening Sen. Mitch McConnell's arguments against provisions in the Democrats' plan to calling for the abolishing of fire departments, Krugman writes:

In his speech, Mr. McConnell seemed to be saying that in the future, the U.S. government should just let banks fail. We “must put an end to taxpayer funded bailouts for Wall Street banks.” What’s wrong with that?

The answer is that letting banks fail — as opposed to seizing and restructuring them — is a bad idea for the same reason that it’s a bad idea to stand aside while an urban office building burns. In both cases, the damage has a tendency to spread. In 1930, U.S. officials stood aside as banks failed; the result was the Great Depression. In 2008, they stood aside as Lehman Brothers imploded; within days, credit markets had frozen and we were staring into the economic abyss.

So it’s crucial to avoid disorderly bank collapses, just as it’s crucial to avoid out-of-control urban fires.

There he goes again, parroting the Wall Street line that "we let Lehman fail and then look what happened after that." I hate to say it, folks, but had the Bush administration "saved" Lehman, we still would have had a huge mess. It was not the failure of Lehman per se that created the temporary Big Freeze on Wall Street, but rather the hard fact that the entire financial industry was infected by the toxic mortgage securities that had become the basis for a lot of financial pyramid schemes.

Likewise, had the Hoover administration and the Federal Reserve System "saved" the banks by flooding them with newly-printed money, as Krugman insists should have been the case, the economy still would have imploded. The problem was not lack of action by the federal government, but rather that the financial system that was undergirded by the Fed was inherently unstable. Furthermore, the new regulation initiatives pushed by Krugman and the Democrats really does not address the larger problem that comes when banks are permitted to engage in something akin to Bernie Madoff's Ponzi fraud.

(In this wonderful speech in which he addresses a number of issues Krugman has raised, Peter Schiff says, tongue-in-cheek, that given Madoff's financial practices, he should have been made Secretary of the Treasury.)

Instead, Krugman envisions a regulatory scheme that is a repeat of what existed before 1980, but now brings the brokerage houses and investment banks into the mix:

Since the 1930s, we’ve had a standard procedure for dealing with failing banks: the Federal Deposit Insurance Corporation has the right to seize a bank that’s on the brink, protecting its depositors while cleaning out the stockholders. In the crisis of 2008, however, it became clear that this procedure wasn’t up to dealing with complex modern financial institutions like Lehman or Citigroup.

So proposed reform legislation gives regulators “resolution authority,” which basically means giving them the ability to deal with the likes of Lehman in much the same way that the F.D.I.C. deals with conventional banks. Who could object to that?

Well, I would object to it for the very reason that I believe that what we would have would be just a larger cartel, but a cartel that would behave exactly the way that cartels behave: cut back production, fund projects that are politically, not economically viable, and make sure there is no financial innovation in the system. Furthermore, the scheme Krugman is pushing does nothing to eliminate the moral hazard in the system, and he knows it. His solution? Let the regulators decide what should be financed, as they always make the right decisions (if they are Democrats, are "smart" and "believe in government.")

Of course, there is the obligatory slap at Reagan, claiming that it was he who gave us financial deregulation when, in fact, the major initiatives began when Jimmy Carter was president and the Democrats enjoyed larger majorities in Congress than they have now. That is the hyper-partisan Krugman at work, but it is falsification of the historical record, and deliberate falsification at that.

Now, Krugman is correct. We can have financial cartels and they will be relatively stable -- at least for a while -- but because the man has absolutely no knowledge of regulation (except he believes in it, provided regulators are Democrats, are "smart" and "believe in government") and apparently knows nothing about the huge volume of academic and popular literature on what really happens in regulatory schemes, he gets it wrong in the end.

The banking cartel whose passing he laments did not come to an end because Ronald Reagan dreamed of free markets. It ended because that cartel could not and would not finance a number of new entrepreneurial initiatives that have marked our economy for the last 30 years. Much of what has driven modern life, from telecommunications to computers to discount retailing came about because these initiatives were financed outside the banking cartel. The pressure to "let the banks compete" came not from Reagan but from the bankers themselves, along with Democrats like Alfred Kahn, who saw the real limitations that the New Deal-era regulations were imposing upon the economy.

Unfortunately, Krugman wants us to forget that in 1980 -- before Reagan even received the Republican nomination for president -- the economy was suffering from high unemployment AND double-digit inflation. Banks were losing capital because of the regulatory restrictions, and we had government-created and enforced cartels in railroads, trucking, finance and telecommunications. It was the Democrats that saw the problems this regime was creating and worked to do something about them.

As always happens in the political realm, the deregulation initiatives turned into schemes to help finance politicians, and whenever an industry, like high-tech, did not give enough political contributions, Congress encouraged anti-trust authorities to move in and make threats, as what happened in the Microsoft prosecutions of the late 1990s. Krugman really does not recognize that situation, nor do I believe that he is capable of understanding it, as his hyper-partisan ideology and his Keynesianism prevent him from absorbing an education in simple economics.

Thus, Krugman's "solution" is just to create an even larger cartel by bringing in the politically-connected brokerage houses and investment banks, but that just is setting up the economy for another crisis, just like what we had in 1980. Krugman, however, does not worry about that problem. Like the economist stranded on a desert island who decided to "assume" a feast was spread before him, Krugman simply "assumes" that government-created cartels will solve all of our economic problems. History tells us something different, but that does not matter. Krugman "assumes" a different history than what really happened.